Look For Stable Earnings When Scouting Dividend Stocks

To CAN SLIM investors, dividends should only be a secondary consideration. But there is nothing wrong with earning a few extra percentage points whenever you can.

When stalking for leading stocks that can grow yet also pay dividends, look for those with stable earnings. This is important because dividends are paid out from a company's profits. Do not automatically pick the ones with the highest yields.

Remember, firms don't have to pay shareholder dividends. Still, many do in order to satisfy shareholders who want to see a return of capital. Companies also pay dividends when they see no investment opportunities that they want to take advantage of.

Dividends on common shares, which are most often talked about, are not set in stone. Companies can reduce or stop paying dividends at their discretion.

During the Great Recession from a few years back, firms such as Bank Of America (BAC), Citigroup (C), General Electric (GE), Pfizer (PFE) and Wells Fargo (WFC) all either slashed or halted their dividend payments to shareholders in order to preserve cash.

Investors can check to see if a company has steady earnings by looking at IBD's Earnings Stability Factor. The rating measures deviations from the past three or five years of quarterly earnings.

Unlike most IBD ratings where higher is better, lower Earnings Stability Factors signal a more steady stream of profits. The Earning Stability Factor goes from zero to 99. MarketSmith's weekly charts show a stock's 5-year factor. The Income Investor column frequently reports a stock's 3- or 5-year factor.

Some dividend-paying stocks with stable earnings have staged big rallies this year.

Home Depot (HD) has gained about 24% this year to outperform a 16% gain for the S&P 500. The stock broke out from a cup base in late January and has been riding its 10-week moving average higher since.

Home Depot has delivered 14 straight quarters of double-digit profit growth. It has a 3-year Earnings Stability Factor of 1, indicating a rock-steady stream of profits. Home Depot's 5-year rating is 14, hurt by an 8% drop in profit in 2010, but still strong. The firm raised its dividend twice in 2011. Home Depot currently has a 2% yield.

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03/30/2015 03:35 PM ET

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